The link between labour market and inflation

The chairman of the US Federal Reserve, Jay Powell, said the link between tight labour market and inflation has been ‘greatly reduced’ in his defence of a careful approach to erase the post-crisis stimulus. In general, when there is a low unemployment rate, it usually means the inflation rate tends to be high, as when more people have jobs, they can afford more goods and services, so the demand for goods and services increases, leading to price increasing, thus inflation occurs. However, this point of view only considers the demand side. When more people enter the labour market, it also means production increases, thus supply increasing, Therefore, whether an increase in employment will cause an inflation or not depends on labour’s productivity. When productivity is better, it is more likely to see a low inflation rate, as there is less excess of demand; if the productivity is worse, it is highly likely to see a high inflation rate ,as there is more excess of demand. From this point of view, the link between labour market and inflation still exists and is strong (significant), only the size of the change will be changed due to different levels of productivity

The weakened link between the labour market and the inflation in the US may be caused by the change in production. If production is no longer dependent of how many workers a supplier employs, then there will be a weaker link between labour market and inflation, as the supply will be independent of the employment rate, then the inflation will solely depend on the demand change created by the change in the employment rate. Furthermore, if people’s incomes do not depend on their jobs but other things, such as their investment (the stock market performance), then the inflation will be independent of the employment rate completely. Both conditions are possible. When companies are adapting to AI and robots, no man is needed in factories, then companies do not need workers to supply goods and services to the market. Moreover, if a country has a welfare system that taxes the rich heavily and provide good benefits for the poor, then people do not need to work to have sufficient incomes to afford their consumption, then the demand for goods and services does not depend on the employment rate any longer.

Overall, the weakened link between the labour market and the inflation in the US I think is caused by the change in production that production nowadays relies much less on human labours.